WEAKNESSES

Erosion of economy's price competitiveness linked to high labour costs

Persistent regional disparities

RISK ASSESSMENT

Sluggish global demand should continue to weigh on activity

After having been less dynamic in 2015, activity should continue to slow in 2016. Low commodity prices will continue to drag on exports of hydrocarbons. Nonetheless, diversification of the economy should mitigate the shock on growth. The country also exports high value-added manufactured products. However exports of electronic goods have been hit by China’s slowdown. And demand from the United States is expected to remain lively but should suffer the economic slowdown in the US. Besides, despite high debt levels, household consumption is expected to remain robust: unemployment is likely to remain contained, the poorest households will benefit from social transfers, social contributions have been lowered and inflation is likely to remain modest, despite the ringgit's depreciation, due to declining food prices.

Meanwhile, the ripple effects of the Economic Transformation Programme will continue to be positive for private and public investment with, in particular, the construction of a high speed rail link connecting Singapore to Kuala Lumpur.

Finally, the sectors linked to tourism are expected to continue to suffer from the effects of the two Malaysian Airlines disasters which occurred in 2014, and the worsening security context in Borneo. Nevertheless the government has eased conditions for entry of tourists coming from China. Manufacturing, moreover, is likely to continue to be hit by a lack of competitiveness.

The budget balance is improving, despite the weakness of hydrocarbons prices while the external position remains sound

In 2016, the budget deficit is likely to keep declining. The government introduced VAT at a rate of 6%, extended the property tax and reduced subsidies for electricity, sugar and petrol. These measures will help offset the fall in fiscal revenues linked to low hydrocarbon prices. The improved budget balance should enable the public debt to be reduced, which, however, will remain at a high level. Moreover, the Malaysian State is also exposed through contingent liabilities which could represent 15% of GDP.

Meanwhile, the current account surplus is likely to slightly decrease because of the worsening trade balance, which is explained by low commodity prices and the slowdown in Chinese demand.

Even if the high level of foreign exchange reserves (close to 6 months of imports) ensures Malaysia has a good capacity to resist sudden flights of capital, the ringgit is under pressure in a context of global financial turmoil because of the drop in oil prices and the political scandal linked to the sovereign fund 1MDB and affecting the Prime Minister. Nevertheless, the US Federal Reserve should delay the tightening of its monetary policy which should enable to contain capital outflows.

Finally, the banking sector is still adequately capitalised and liquid. Nevertheless, high household debt levels and the banks' exposure to foreign assets are a risk.

The prime minister has been weakened by the 1MDB scandal

Despite the victory of the Prime Minister's party, Barisan Nasional (BN), the general elections of May 2013 confirmed a redistribution of political forces and the rise in power of the opposition initiated during the 2008 elections. Nonetheless the legitimacy of Prime Minister, Najib Razak, was confirmed by his victory during the party's internal elections in October 2013. However, suspicions of corruption, of embezzlement and poor management of the 1MDB public investment fund have weakened the prime minister since July 2015. The attorney general has cleared Najib Razak but the anti-corruption agency appeled against this decision and foreign jurisdictions are also investigating the case. A former prime minister called for the resignation of Najib Razak who dismissed his deputy and the former attorney general. However, he continues to benefit from his party's support. Internal elections within the prime minister's coalition will not take place until after the 2018 parliamentary elections. Despite these scandals, the country is expected to continue benefitting from a business climate made favourable in particular by the quality of its regulations.

Lastly, the NB is keen to use its One Malaysia programme to end the New Economic Policy introduced in 1969 - positive discrimination measures favouring the Bumiputra (indigenous Malays) - and seen, in particular, as a disincentive to foreign investment. However, community tensions remain below the surface due to religious and ethnic diversity.